Traders are preparing to start the new week with a new set of challenges.
Last Sunday started a new book in the US/China trade war saga. The president kicked off chapter one with a promise to raise tariffs on Friday if there was no deal. Each day presented a new view of the negotiations and the potential for a resolution. On Friday the tariffs rose from 10% to 25% on $200 billion in Chinese goods. The current talks ended and no future talks are scheduled. Over the weekend the president warned China they had better negotiate a good deal now rather than hope a democrat was elected in 2020. If they did not deal now the deal after 2020 would be a lot harsher. The vice premier warned there would be no deal without dignity and the end to all tariffs. In my mind there is slim to no chance of that happening.
Traders are preparing to enter week two of this saga and the Asian markets are mixed on Sunday evening. The Shanghai index is up 3.1% and the Hang Seng is up 1% while the Nikkei is down -0.3%. What is wrong with this picture? You would expect the Asian markets, especially China, to be down after tariffs were raised to 25%. This is probably China's equivalent to the Federal Reserve Plunge Protection Team. This team can and has injected cash into the equity markets in times of stress. China may be injecting cash into their equity market to prop up sentiment. On Monday the president will release his plans on the next round of tariffs on even more Chinese exports.
The US markets were down between 2-3% and that is considered a normal pause for profit taking. Obviously, the tariff threat last Sunday triggered it, but the indexes had been struggling for two weeks to make new highs. Volume was light and gains were minimal. We were due for profit taking and the major indexes were telegraphing that fact. The China trade news just triggered the profit taking event.
I remain concerned about direction even if the market opens higher on Monday. With earnings in Q1, Q2 and Q3 expected to show only 1% growth, and the trade war likely to drag on, we could see a real sell in May cycle this year. Anything contrary to that would be suspect until proven to be real.
We just exited an ugly week and the rebound on Friday may have just been short covering. The tariff announcement by the president last Sunday night was the start of a major decline in equities but end result was only a 2.2% decline in the S&P and 3.0% decline in the Nasdaq.
The outlook for the market is negative. While the Friday rebound was blamed on the Mnuchin and Trump comments "negotiations were constructive" anyone with a brain can see there is trouble ahead. The negotiations have stalled with "no further meetings are scheduled" and both countries are firming up their verbal defensives to try and claim the high ground.
Regardless of what China says, they need us more than we need them. They have a billion workers they need to keep working and they require the export income to fund their government spending. Most of the large companies have government ownership positions so a portion of the profits goes to the government. China has implemented 72 stimulus actions to date in 2019. They are working hard to keep the economy moving but they need exports. They can produce all the products they want but much of that goes to the USA.
The resumption of hostilities by President Trump put President Xi in a bad position. As the vice premier said on Friday, the agreement must be structured in such a way to provide each country with dignity. Xi cannot be seen as caving into President Trump's demands. He would lose face in China and that cannot be allowed. This means Xi must stiffen his resolve and maintain a strong front to his people.
Because it is a communist country, Twitter is not allowed. Chinese citizens do not know why their market cratered last week. The news was not allowed to mention trade negotiations. Screenshots of Twitter posts were scrubbed from the internet to prevent them from being received by email or text and forwarded to others. Videos and news items from the US were blocked. Every way the information could come into China was monitored and censured.
That is actually positive for the negotiations since the citizens do not realize there is a big trade fight in progress. Some may know and some may be passing it along, but the vast majority of the 1.3 billion citizens are clueless.
We are likely going to be inundated with trade headlines for the next month and they will increase as China's time runs out. The president will continue ratcheting up his demands and threats and that will roil the market.
We are now in the "sell in May and go away, come back again on Labor Day" period. The first ten days of May have been ugly and with 1% earnings growth in Q1, Q2 and Q3, there is little to entice investors back into the market. They call it the summer doldrums because many investors take the summer off. They do not want to be worried about their positions while they are hiking the mountains, swimming at the beach, on a cruise to the Caribbean or a road trip with the family. Starting the summer off with a 5% decline is a way to push these retail investors back into cash for the summer.
The S&P has traded below the 50-day at 2,861 for two consecutive days but closed back above that level. In theory that support has held. The 2,872 support that held in early April is also back in play. Resistance is back at 2,900 and the new closing high is 2,945 or 64 points above Friday's close. I would be very surprised if we saw that level again next week. We have a better chance for a decline than a rally.
The Dow continues to be hammered by large declines in a handful of stocks. 3M, Boeing, Caterpillar, etc, have erased more than 1,000 points from the Dow in recent weeks. The index is trading back below 26,000 after coming to a dead stop at the 26,616 resistance for two weeks. The lack of Dow components reporting earnings this week could be a plus. Walmart is the only reporter. A lack of multiple reporters means a lack of stocks losing a lot of points. The rest of the index should be calm with the exception of the tariff sensitive stocks.
The Nasdaq was down sharply intraday to 7,759 but rebounded nearly 60 points to close at 7,917 and well over the 50-day average. This was the second day the average was penetrated but the index rebound to close over that level. This is positive and hopefully it holds. The big cap tech stocks were evenly mixed on Friday with the exception of the $94 gain in Booking Holdings, formerly Priceline.com. They missed on earnings but rose anyway.
The Russell 2000 did not lose more than the big cap indexes with only a -2.5% decline. That put us back to the correction level support at 1,566 and the combination of the 50/200 day averages provided additional support. This is somewhat encouraging that small caps did not implode but that is because they are less impacted by events in China. Most are domestically focused companies and immune from a lot of the global trade battle. It also suggests fund managers are not yet ready to pull the plug on the market.
We have an active economic calendar for next week, but the only material report is the Philly Fed Manufacturing Survey on Thursday. None of the reports this week should be market movers if the numbers are near the analysts' expectations.
The earnings calendar was cut in half this week but there are still some big names. Cisco, Nvidia and Walmart are the big dogs.
Of the 448 S&P companies that have reported Q1 earnings, 75.4% have beaten expectations. The current earnings forecast of 1.3% growth is significantly better than the -1.8% decline forecast from just a couple weeks ago. 56.9% of companies have beaten on revenue with the Q1 forecast now 5.6% growth.
For Q2 there have been 48 companies with negative guidance with 19 companies issuing positive guidance. Only 9 S&P companies report earnings this week. The Q2 forecast is now for 1.2% growth and 1.8% for Q3. Those numbers are very anemic.
I am worried about the market in the weeks ahead. The indexes were struggling to try and make new highs when it was thought there would be a trade deal at any time. Without that carrot hanging over the market there is nothing to keep traders interested through the summer doldrums. Memorial Day is only two weeks away and that is the kickoff of the summer vacation season. Schools are already closing for the summer and that means more demands on parent's time and attention. There is nothing to prevent the market from posting gains but there is nothing to entice those gains. Earnings at 1% and a full-blown trade war should not produce positive headlines. I would not trust a market bounce at the open on Monday.
Enter passively and exit aggressively!
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